- The Spanish government expects the recession to come to an end by mid-2013. In an environment of fiscal tightening and sliding house prices, that appears to be wishful thinking.
- Even if Spain manages to deliver the anticipated -0.5% growth in 2013, this does not justify the government's expectations that the unemployment rate should decline slightly in 2013. It is simply at odds with the empirical evidence.
- We expect that the Spanish economy will contract 1.5% or more in 2013, that Spain will miss its fiscal target and that the unemployment rate will rise to at least 26.5%.
The Spanish government expects an export-driven recovery that will bring Spanish growth back into positive territory by mid-2013. The assumption is that Spanish exports can grow 6-7% annually in 2013-15. This may materialise if global growth picks up notably or Spain manages to win global market shares, e.g. in services and green energy. We find that it is an ambitious target that may prove difficult to reach, though not impossible. A driver for winning market shares is to become more competitive. The new government has undertaken a lot of reforms during the last 10-11 months. But it is no time for complacency. Looking at the business climate and unit labour costs, we believe that Spain is really only halfway through the needed reform agenda.
However, our real concern is that even if exports grow as much as anticipated, the contraction in domestic demand will be much bigger than the government anticipates.
Austerity and fiscal multipliers
The Spanish government needs to reduce the fiscal deficit by at least 1.8% of GDP next year to reach its target. This will have a substantial negative impact on growth. In an economy operating close to its capacity constraint the fiscal multiplier is probably close to zero, as the private sector will replace public sector cuts. However, when demand is lacking, as is the case in Spain, there is little reason why cuts in the public sector should cause an increase in private sector production. Until recently, IMF consensus was a fiscal multiplier around 0.5, but in October IMF chief economist Olivier Blanchard and Daniel Leigh emphasised that during recessions the multiplier is probably in the range of 0.9 to 1.7. In the absence of a central bank response, the multiplier is probably at the high end of this range. Assuming a fiscal multiplier of 1.5 means that a 1.8% cut in the budget deficit should pull GDP growth down by as much as 2.7%.
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